Mania strikes…

  • More things to worry about
  • Coming next week
  • New episode

It’s a pun-lovers dream.

The British tabloid press would go ‘gaga’ or ‘cuckoo’ over it.

We’re talking about the next biggest and ‘bestest’ investment trend that really is sweeping the markets.

Colleague Sam Volkering has been all over the story. I’d say he’s getting ‘high’ about it, but the ‘pun police’ would have us up on charges before you can say, ‘Hey man, we’re all cool cats here.’

Sam calls it his ‘Marijuana Mania’ investment theme. You could call it a ‘Cannabis Caper’ if you like, or a ‘Weed Wonderland’, or a ‘Pot Potpourri’ or… [Reader’s voice: Enough already].

Anyway, check it out. This story has only just started, and it isn’t about to end anytime soon. Details here.

Markets

Overnight, the Dow Jones Industrial Average gained 2.46 points, or 0.01%.

The S&P 500 closed up 1.89 points, or 0.08%.

In Europe, the Euro Stoxx 50 index added 20.27 points, for a 0.6% gain. Meanwhile, the FTSE 100 fell 0.27%, and Germany’s DAX index gained 0.09%.

In Asian markets, Japan’s Nikkei 225 index is up 243.92 points, or 1.26%. China’s CSI 300 is down 0.02%.

In Australia, the S&P/ASX 200 is currently up 32.5 points, or 0.57%.

On the commodities markets, West Texas Intermediate crude oil is US$49.59 per barrel. Brent crude is US$52.19 per barrel.

Gold is trading for US$1,198.95 (AU$1,597.14) per troy ounce. Silver is US$16.91 (AU$22.53) per troy ounce.

The Aussie dollar is worth 75.06 US cents.

More things to worry about

The Wall Street Journal reports:

U.S. household net worth climbed to a record $92.8 trillion in the fourth quarter of 2016, as the end-of-year surge in stocks and a steady climb in home prices added more than $2 trillion of wealth to household balance sheets.

The biggest contributor to the increase was the stock market, which added $728 billion to household balance sheets in the fourth quarter, according to the Federal Reserve’s quarterly financial accounts report.

It’s an interesting observation.

In what has been one of the most ‘bearish’ of economic recoveries in living memory, US stocks have soared to record highs, US household worth has compounded higher, and US gross domestic product (GDP) has similarly grown.

Yet there’s still an underlying feeling that many Americans are no better off today than they were 10 years ago.

The ascendency of Donald J Trump to the US presidency is at the least anecdotal evidence of that claim.

The following chart shows how household net worth (white line and right-hand axis) has grown compared to US GDP (blue line and left-hand axis):



chart image

Source: Bloomberg
Click to enlarge


On the surface, that’s all fine. But the thing that intrigues us is the relationship between GDP and household net worth, and whether it can tell us anything.

Now, we’ll concede that taking two numbers and deriving an outcome from them is about as easy as it gets. You can do that with any two numbers.

Tylervigen.com/spurious-correlations is a wonderful website. It shows how you can take two completely random things, plot them on a chart, and erroneously state that there is a correlation between them.

For instance, there is a spurious correlation between ‘US spending on science, space, and technology’ and ‘suicides by hanging, strangulation and suffocation’:



chart image

Source: Tylervigen.com
Click to enlarge


Likewise, there is a spurious correlation between the ‘number of people who drowned by falling into a pool’ and ‘films Nicholas Cage appeared in’:



chart image

Source: Tylervigen.com
Click to enlarge


Finally, there is a spurious correlation between the ‘divorce rate in Maine’ and ‘per capita consumption of margarine’:



chart image

Source: Tylervigen.com
Click to enlarge


I’ll leave it there. You get the point. But if you have a spare 20 minutes to waste, the website is well worth visiting for a laugh or two.

The reason we mention it is that, in our analysis of the correlation between US GDP and US household net worth, we have to be aware of the potential for a spurious or unrelated correlation between them.

But, then again, correlating things is what we do. Sometimes we’re happy to trump the correlation (or inverse correlation); other times, we’re happy to pooh-pooh it.

In this case, we raise an eyebrow in the data’s general direction. Because, to our mind, a correlation exists, and it’s one that investors would do well to acknowledge.

To show our point, we’ve taken the year-end data from the chart we produced previously and, for your ease, placed it into a table. You’ll see it below:



chart image

Data Source: Bloomberg
Click to enlarge


The left-hand column shows the year-end date. Easy.

The second column shows US household net worth in billions of dollars. Therefore, in 1998, US household net worth was US$38.1 trillion.

In 2016, it was US$92.8 trillion.

In the third column, we show US GDP. Likewise, it’s in billions of US dollars. In 1998, US GDP was just over US$9 trillion. In 2016, it was just over US$18.5 trillion.

The fourth column is the one that’s of most interest to us, and which should be of most interest to you.

Here, we’ve simply divided US household net worth by US GDP. It gives us a crude ratio.

In 1998, US household net worth was 4.19-times US GDP. By 1999, it had risen to 4.44-times…before falling. Coincidentally (or by correlation), the US economy moved into recession soon after, and stock markets fell from the peak.

By 2006, US household net worth was 4.78-times US GDP. Coincidentally (or not), that was the top of the US housing market. The following year saw the top of the US stock market.

The year after that, markets crashed. By the end of 2008, US household net worth was just 3.82-times US GDP.

From there, things have turned. Again, correlation?

Until we now reach 2016 and, according to the data, US household net worth is now five-times US GDP. That’s the highest multiple since at least 1998.

A time to worry? Or is it just a purely spurious relationship?

Well, we’re not inclined to see it as spurious. There should be a relationship between household worth and GDP. If people are becoming wealthier, that should reflect in the ‘wealth’ of the nation.

But the key point here is how the multiple has grown at, or near, the peak of the market cycle. Why would that be?

Put simply, we would say that debt plays a major role in this. The more the market and economy grows — and appears to grow — the more that people are willing to borrow in order to leverage returns to a growing market.

Australia is a case in point with rising house prices. The rising US stock market is surely another case.

Again, we can produce another chart to show correlation. The red line shows the New York Stock Exchange (NYSE) margin debt. The blue line shows the performance of the US S&P 500 index:



chart image

Source: Advisor Perspectives Inc.
Click to enlarge


NYSE margin debt now stands at a level roughly 20% above the previous high in 2007.

In other words, we can’t argue that US household net worth has grown. But we can argue that perhaps the newfound wealth isn’t as sustainable and long-lasting as many would have you think.

Some see rising household wealth as a positive sign. We see it as a warning sign.

Then again, we tend to see everything as a warning sign, so do with the information what you will.

Coming next week

By the way, this is all tied into the latest research from colleague Vern Gowdie. More details will be made available next week. Stay tuned.

New episode

Remember to check out the latest episode of the Financial Anarchists podcast. You can download it via iTunes or Stitcher, or from any podcast player.

In this episode, my co-host asks me for a pay rise…so I tell him where to go. Listener discretion is advised!

Cheers,
Kris